Using CFDs for active investment management
Translating the needs and goals of diverse households into appropriate investment decisions is a daunting task.
The basic framework involves dividing the investment process into two main investment approach: passive and active.
With the passive approach (Buy & Hold), the investor decides to buy an asset for a certain period of time, and then to maintain the position until the end, without modifying the position.
Using an active approach, on the other hand, the investor can reduce their risk exposure, particularly the price volatility, by periodically modifying the asset allocation using specific financial instruments.
CFDs (contracts for difference) are an instrument which allow the investor to profit from a falling price.
The investor, using CFDs, can go long and/or short the underlying stock or equity index.
Financial theory supports the idea that active portfolio management, on the back of risk monitoring and of investment position adjustment, tends to perform better than a passive strategy, after a certain period of time (generally considered to be around 18 months).
The basics of CFDs
CFD investment involves only a small percentage of investors' liquidity because of trading on margins (*), so using CFDs the investor can invest less than the total amount of the deal.
Using CFDs the investor can buy or sell the CFDs underlying: the stock or the equity index correlated to the CFD price.
The investor can trade UK, US and European shares, equity indices on the back of the correlation between CFDs price and the underlying price. It is also possible to trade CFDs on currencies and commodities.
If you are a UK investor, using CFDs you are also exempt from stamp duty.
(*) Purchasing stocks or CFDs on margin means that the investor borrows part of the purchase price of the stock or CFD from a broker. The margin account is the portion of the purchase price contributed by the investor; the remainder is borrowed from the broker. If the margin is 10% of the purchase amount, it means that the investor could deposit just 10% of liquidity and could participate in the investment for 100% of the purchase amount, with the broker financing 90% of the deal. In this case, the participation rate is 1:10 or 10 times the initial margin.
Examples of active management using CFDs:
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